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Property Transfer Scheme Quashed by Courts

19/02/2019


This article was originally published on the Canadian Tax Foundation website and has been reproduced with permission.

Balaji Katlai, CPA, CA

The Federal Court of Appeal’s (FCA) application of the General Anti-Avoidance Rule (GAAR) to a property transfer by partnership allocation in B.C. has implications for corporate partnerships across the country.

In Canada v. 594710 British Columbia Ltd. (2018 FCA 166; leave sought to appeal to the SCC), the FCA overturned a TCC decision (2016 TCC 288) and applied GAAR on the basis that the taxpayer abused section 160. This section is intended to prohibit a person with a tax liability from avoiding the collection of tax by transferring property to a non-arm's-length person for inadequate consideration. Although the situation concerned a partnership loss transaction, the court disposed of the appeal without commenting on the wider issue of whether there is a general scheme in the Act against transferring losses, as suggested by the Crown. 

The case involved a partnership structure that consisted of four Partnercos (incorporated for real estate construction projects) that were indirectly owned (99.9 percent) by four brothers through individual Holdcos. The remaining nominal interest belonged to a general partnership held by one of the brothers.

Toward the end of the project, the members of the partnership were faced with taxable income of close to $13 million. They attempted to mitigate their tax liability by bringing into the partnership an unrelated public corporation with available tax losses and deductions (Nuinsco) just before the partnership's year-end. Virtually all of the partnership's income for tax purposes was allocated to Nuinsco. As a consequence of this transaction, there was no taxable partnership income to allocate to the individual Holdcos. The CRA's reassessment of one of these Holdcos (the respondent) on the basis of GAAR was the subject of this litigation. 

The FCA ruling was based on whether the object, spirit, or purpose of section 96 was frustrated within the series of transactions. The court found that it was:

The result of the series of transactions was that the . . . family had shifted the entire taxable income from the development to an unrelated party which had virtually no economic interest or risk, except for a 10 percent "deal fee." I agree with the Crown that this defeats the object, spirit or purpose of subsection 96(1) and therefore there is an avoidance transaction that is abusive. [Paragraph 71]

Further, there was no common business interest toward profit when Nuinsco entered the partnership. This defeated the spirit and object of section 96 since the allocation of the income was skewed to Nuinsco, which had no common business interest with the partners; the only intent was to avoid a tax liability. Such a requirement for common interest was highlighted in an earlier SCC judgment: Mathew v. Canada (2005 SCC 55). As a result, the FCA concluded that the application of GAAR to Partnerco resulted in Partnerco being allocated a portion of the partnership's taxable income, and therefore to have a tax liability for the purpose of section 160. 

The series of transactions also caused a transfer of cash from Partnerco to Holdco without consideration (through a combination of a stock dividend and redemption). Thus, by the creation of a deemed year-end in Partnerco after a transfer of property but before the tax liability was incurred, the application of section 160 was circumvented. Together, these actions showed a tax benefit, an avoidance transaction, and an abuse of section 160—accordingly, GAAR applies to Holdco. 

An interesting aspect of this particular FCA ruling is the lack of reliance on a specific provision within the Act regarding loss trading or profit trading. (This issue was part of the basis for the TCC ruling in favour of the taxpayer.) Rather, the FCA concluded that the object, spirit, or purpose of subsection 96(1) was frustrated, which led through a chain of analysis to the application of GAAR on the basis of an abuse of section 160. 

Read the original article on the Canadian Tax Federation website.